US markets catching up: the Nifty could still go places

Goliath is finally catching up with David. The biggest equity market in the world - the US - is finally catching up with the much smaller Indian stock bazaar. The journey of both markets to these near all-time-high levels has been interesting with the Indian market rallying despite tight money policies and US pushed by easy money.

So what are the implications? Is this good for the markets overall or does it mean nothing? Must investors be happy or cautious? We will look at the trend of the market in both countries over the past 15 years to see what the charts are telling us.

Well, first of all, when markets move in sync it’s always good. Leading and lagging markets tend to make investing more confusing. So, generally speaking, there is some good news. But there is also need for caution. Firstly, caution is warranted because the Indian and US equity markets are reaching previous all-time highs. This generally leads to a correction or trend reversal. It is also possible for both markets to stay stalled around their previous highs for a long time.

Let’s look at the charts to see what they are telling us. ( Click here for the combined chart of the Nifty and S&P 500. The chart at the top is that of Nifty) . Like we said earlier, it’s good that both markets are moving towards their all-time highs in sync. Generally the Indian markets have tended to rally first only to be pulled back when out of sync with the US markets. For instance, the S&P 500 topped in October 2007 and began falling. However, the Nifty continued to rally and began falling in January 2008. Clearly the Nifty could not continue to rally with the S&P 500 going in a different direction. The turning points are shown by green vertical lines on the chart.

Then in November 2010, the Nifty rallied to touch its previous all-time high, as shown by the red vertical line on the extreme right of the chart. However, the S&P 500 was far away from its previous all-time high (as shown by the red vertical line on the S&P 500 chart) and we saw the Nifty correct. Clearly there was substantial weakness in the US markets relative to the Indian markets, which can be attributed to the correction in the Nifty.

Now the S&P 500 has almost caught up with the Nifty with the former being about 6.25 percent below the top and the latter about 5.75 percent. This essentially increases the possibility of a break out to new highs for the Nifty. A supporting breakout by the S&P 500 would be a positive for sustaining a Nifty breakout, but not necessary. You ask why. So let’s go back to the charts again and look at past price action of both indexes.

Notice the white horizontal line on the extreme left of the chart which shows the 1998 lows of both indices. The blue vertical line shows the high of 2000 for both indices after which the markets fell. The S&P 500 fell due to the Dotcom bust. Now look at the white vertical line to the right of the blue vertical line. You will notice that the S&P 500 made a low that was lower than the 1998 low, but the Nifty did not, showing that the Indian markets were relatively strong. Now let us fast forward to 2007 as shown by the green vertical lines and you’ll see that the Nifty made all-time new highs when the S&P 500 was only able to touch its 2002 highs.

Now, let’s look at the March 2009 lows as shown by the white broken vertical lines. Notice that the S&P 500 went a little below its 2002 lows, but the Nifty did not. This again indicates the relative strength of the Nifty. Heck the S&P 500 is still about 6 percent below its 2000 peak, while the Nifty is nearly 240 percent above its 2000 high. If that does not show the relative strength of the Indian markets, nothing else will.

So while the S&P 500 has been range-bound for the past 10 years, the Nifty has been going places. This makes clear that we will not need breakout new highs on the part of the US markets, for the Nifty to show new strength.

Will the Nifty break to new highs? Firstly, the more the number of times the previous all-time high is hit, the greater the chance of a breakout. The Nifty has hit it once already in November 2010 and is going up there again. It formed its all-time high in 2008. In 2007, the S&P 500 too hit its all-time high which was formed in 2000. It is now going back up to its highs again. But like we have always said, let a breakout happen and be sustained before turning more bullish. As markets approach prior peaks, we tend to get bearish unless there is a sustained breakout.

Fundamentals, nominally speaking: Before people start thumping their chests about the fundamental strength of the Indian economy leading to the multi-year rally of the Nifty, let us look at the nominal factor. India has been deficit financing (which means printing notes) the government for several decades. It is also a high inflation economy coupled with a depreciating currency. All this means that even though the nominal value of the Indian stock market is up, it’s real value may not be so high. With inflation and currency depreciation driving up the price of everything, more money gained from the stock market appreciation will not really buy you much more in real goods and services.

In the US, on the other hand, a low inflation rate and less depreciating dollar means that even if the stock markets have not made new highs the proceeds from the sale of stocks still have much more purchasing power than the rupee. All that may change with the Federal Reserve printing money without control over the past few years.

We refer to the nominal issue only to point out that real value may not have appreciated enough. But that does not mean one should stay out the equity market. Given the nominal abuse that government puts citizens through, it is important to invest in stock markets to protect one’s savings from the consequences of that abuse - high inflation and rapid currency depreciation.

Sensex and Nifty now: The indices are struggling to meet the upside targets we mentioned in previous articles. But that should not come as a surprise as the indices are near all-time highs, making further rallies fraught with volatility and higher potential of failure.

George Albert is Editor, www.capturetrends.com